EC: The EU corporate governance framework

Comments from ACCA to the European Commission, July 2011.

ACCA is pleased to respond to the European Commission Green Paper on the EU Corporate Governance Framework. ACCA, as a global professional accountancy body with 147,000 members and 424,000 students in 170 countries, is an active contributor to developments in corporate governance in Europe and around the world. ACCA works to achieve and promote the highest professional, ethical and governance standards and advance the public interest.

General comments

We commend the Commission on the thoroughness of the consultation and its analysis of the factors which impede effective corporate governance. We agree it is correct to focus on the effectiveness of boards, the role of shareholders in holding boards to account and the effectiveness of the ‘comply or explain’ approach to enforcement.

Recent corporate events have shown that, despite years of evolution and growing complexity and prescription in corporate governance, and major reform following scandals at Enron, WorldCom and Parmalat, the present approach to governance is missing something fundamental. Adding further complexity can be of only limited value. Reviews of governance at financial institutions in the period leading up to the crisis highlighted that the problem is behavioural. Unfortunately, few of the reforms so far proposed address the roots of the problem and some appear to amount to little more than doing something simply to claim that something has been done. Governance requirements currently focus on structure, eg of boards, and urging the various players to do the right thing, eg for non-executive directors to provide challenge and make sure executives do not lead the company over a cliff. Most reforms simply build on this approach. If we are seeking real and lasting improvement in corporate governance, and the consequent benefits to company performance, shareholder value and society, it is essential to address the incentives and motivations that drive behaviour. In companies and on boards there are powerful disincentives for people to challenge. Shareholders too have little incentive and limited power to enforce the ‘comply or explain’ approach.

Ever growing regulation often has unintended consequences. Too often, rules are seen as a challenge to overcome so that the essential aim of a regulation is frustrated even if there may appear to be compliance. It is vital, in our view, for the regulation of governance practice to focus on principles and outcomes rather than prescription.

Regulatory reform should focus on removing the disincentives and supporting or adding to incentives for good governance. It is important to remember that good governance is more about good corporate behaviour and having the right strategy, motivation and means to build long term value than about complying with a code.

We suggest that governance practice can best be improved by companies providing better explanations of how they apply good practice governance principles which shareholders should then use as a basis for more informed engagement. This way shareholders can become more effective in holding boards to account helping them steer their companies to success. The EC should consider how best it can facilitate this.

Our responses to the questions in the Green Paper reflect these views. Our views are discussed in more detail in our paper ‘Risk and reward: tempering the pursuit of profit’ published in 2010 (please see the Related documents box at the bottom of this page).

On a separate point, we note the reference in the first paragraph of the Green Paper to ‘ambitious growth targets’ set by ‘Agenda 2020’. The current sovereign debt problems for some nations are a consequence of stimuli for economic growth which proved unsustainable. We suggest that it would be prudent to consider less ambitious growth targets.

ACCA responses to the questions in the Green Paper

Preliminary questions

1. Should EU corporate governance measures take into account the size of listed companies? How? Should a differentiated and proportionate regime for small and medium-sized listed companies be established? If so, are there any appropriate definitions or thresholds? If so, please suggest ways of adapting them for SMEs where appropriate when answering the questions below.

It is natural that attention will focus on the largest companies. The economic influence and social footprint of the largest 100 European companies is probably greater than that of all the other listed companies put together.

The principles of effective governance, however, are the same for small listed companies as well as large ones. The way the principles can best be implemented will differ, which is why a flexible approach is necessary. The alternative would be to have elaborate prescription of practice for different sizes of company; this would be bad for business and in no one’s interest apart from for those who make a living from governance complexity. Where possible, regulatory reform should aim to simplify governance requirements to a few key principles then create the right environment for them to be applied.

We are not clear whether the reference in the question to SMEs is to listed companies or small and medium sized unlisted companies. There is no need for the EC to consider governance regulation for unlisted companies.

2. Should any corporate governance measures be taken at EU level for unlisted companies? Should the EU focus on promoting development and application of voluntary codes for non-listed companies?

No. The owners of shares in limited companies are generally far more engaged in the governance and management where they are also directors. The owners and directors also generally have a much greater interest in the long term success of their companies. Governance problems in unlisted companies are therefore generally of a very different nature. The main problems for a board of an unlisted SME tend to be around succession and shortage of resources and for shareholders they are about founders or families wishing to retain control and protection of minority shareholders. There is no obvious need for further regulation in this area.

Boards of directors

3. Should the EU seek to ensure that the functions and duties of the chairperson of the board of directors and the chief executive officer are clearly divided?

There is no need for regulation on this. It would be wrong to be categorical and one should avoid dogma. It is probably preferable for the two roles to be held by different people, at least in large stable companies. The main reason for this is to make it harder for one person to dominate decision making and to avoid that person making bad decisions. We are not aware though of any strong body of evidence to suggest that companies are more successful, and there are plenty of examples of company failure or poor governance, where the roles are split.

It can be argued that at times it may be better for one person to do the job. This could be the case where there is an outstanding leader; we note that shareholders are generally content for the roles to be combined if the company is successful until something goes wrong. It could also be appropriate for entrepreneurial companies in a growth phase and if a company is in difficulties and a new approach is needed quickly. It may also be necessary temporarily if a suitable person to fill a post is not available.

4. Should recruitment policies be more specific about the profile of directors, including the chairman, to ensure that they have the right skills and that the board is suitably diverse? If so, how could that be best achieved and at what level of governance, ie at national, EU or international level?

No. To require this would mean over engineering corporate governance. Boards of large companies are never short of advice on who the ‘right’ people are. Nevertheless there does seem to be a degree of short sightedness over which people to consider. We are strong supporters of diversity in general and would support initiatives to put the business case for greater diversity on boards. It should then be a matter for common sense and informed self interest for boards.

5. Should listed companies be required to disclose whether they have a diversity policy and, if so, describe its objectives and main content and regularly report on progress? 

Such a requirement would probably have little impact on improving diversity. It is also important to remember that companies exist to create value for shareholders by providing goods and services that people want. A diverse board should, hopefully, mean a board which is more effective in creating value but we should avoid confusing ends and means. A diverse board may be a means to an end but it should not be seen as an end in itself.

6. Should listed companies be required to ensure a better gender balance on boards? If so, how?

It is important that any company has the best people it can on a board and that that board can work effectively together. A little friction and dissent is a good thing and all chairmen should encourage openness, challenge and diversity of thinking. It follows that diversity in membership, including diversity of gender, should be actively encouraged but it would probably be counterproductive to compel boards to make appointments to meet a target or fulfil a quota. In future, shareholders may be keener to encourage more diverse boards.

There are wider policy issues to address. There are many other reasons, besides lack of inclination by existing board members, for women to be under represented on boards. Some of these will be to do with the work life balance and the long hours culture. It may be that fewer women wish to be on boards but it also doubtless true that many women are unable to progress to the boardroom because of family commitments and lack of childcare, perhaps when they were much younger. There may also be additional steps that could be taken within companies to encourage and facilitate career progress by women. We suggest these are a matter for further research.

7. Do you believe there should be a measure at EU level limiting the number of mandates a non-executive director may hold? If so, how should it be formulated?

No. Such a measure would be impracticable, it would also engineer requirements. Directors should be expected to devote whatever time is needed to the post they have taken on. This will naturally impact on the number of mandates they accept. Shareholders should see that directors contribute the appropriate levels of time commitment.

8. Should listed companies be encouraged to conduct an external evaluation regularly (eg every three years)? If so, how could this be done?

Boards should be encouraged, but not forced, to do so. An external evaluation is not necessarily better and it is perfectly possible in theory for a highly effective internal evaluation be made and the EC should be careful not to create a consultants’ charter. There is a danger that boards will avoid using independent facilitators who may have an innovative approach and restrict themselves to using the usual large firms, most of whom also offer remuneration and head hunting services so are potentially conflicted.

It would be a mistake to think that an external evaluation means ‘better governance’ and to create yet another opportunity for people to think they can assess governance by ticking a box to say ‘external evaluation’. The important thing is for shareholders to be interested in the quality of the evaluation and its results.

We suggest that the results of the board evaluation should include consideration of the board’s success in growing value for shareholders and that this be related to remuneration policy.

9. Should disclosure of remuneration policy, the annual remuneration report (a report on how the remuneration policy was implemented in the past year) and individual remuneration of executive and non-executive directors be mandatory?

It is mandatory in the UK but it has had the unintended consequence of ratcheting up directors’ pay. No executive director wants to be in the lower quartile, remuneration committees usually agree and shareholders tolerate the situation providing pay proposals are not too far from the normal upward trend. Pay policies and arrangements can be very complex so it is hard for anyone not closely involved to know what a pay policy will mean in practice, particularly when the policy may determine performance pay several years in the future. ACCA has previously suggested that companies disclose the multiples of executive pay to average employee pay and the trend over time as a way of making this ratcheting more transparent. Something like this is now being adopted in the US.

Pay policy should explain how pay is linked to both board performance and corporate performance. It should also demonstrate how the board assures itself that its pay policy cannot incentivise directors to enrich themselves at the long term expense of the company, eg does not incentivise risk seeking for short term personal gain.

Although many claim that market forces determine directors’ pay, the reality is that no market exists in the normal sense of the term. The fact that in the US and the UK executive pay has over the last 15 years consistently increased faster than average employee pay and with little relation to corporate performance confirms this. Directors will pay themselves what they like if there is nothing to stop them.

If such disclosure becomes mandatory, it is essential for it to be clear, not over complicated and to enable readers of reports to calculate the pay which the policy implies. It is also essential that shareholders are prepared to and do restrain pay and not just the most egregious examples.

10. Should it be mandatory to put the remuneration policy and the remuneration report to a vote by shareholders?

Despite the obvious limitations, the non binding vote on pay policy seems to have helped restrain excesses in pay in the UK although it has not altered the general upward trend. A vote on this issue can also make a contribution to the wider cause of encouraging shareholder involvement and engagement with the board.

11. Do you agree that the board should approve and take responsibility for the company’s ‘risk appetite’ and report it meaningfully to shareholders? Should these disclosure arrangements also include relevant key societal risks?

We strongly agree that boards should take responsibility for understanding the level and nature of risk it is willing take and prepared to accept and does take and to report meaningfully to shareholders how they have done so.

We also agree this should include risks to society and not just to the company. Recent events in the financial and energy sectors have highlighted the risks that companies’ activities pose to society, the economy and the environment. Corporate governance should be concerned with companies’ moral obligations to stakeholders.

12. Do you agree that the board should ensure that the company’s risk management arrangements are effective and commensurate with the company’s risk profile?

Of course.


13. Please point to any existing EU legal rules which, in your view, may contribute to inappropriate short-termism among investors and suggest how these rules could be changed to prevent such behaviour.

The quarterly reporting provisions in the Transparency Directive drive are the obvious benchmark. But they may be a symptom of the way that the market works as much as the cause. All investor groups track the performance of their investments on the basis of quarterly returns. The answer must be for investor groups and the market generally to perceive the virtues of a longer term and more holistic basis of assessment of the investment performance.

The EC governance framework also encourages a compliance, rather than a principles, approach to governance. An approach based on the key governance principles and how they are practiced should stimulate boards and shareholders to take a more balanced longer term view.

Generally investors are more interested in financial results than in any narrative disclosure. Since there is clearly more to assessing a company’s prospects than its past results, this suggests that the reporting framework falls short in some important way. If corporate reports gave useful information relevant to future prospects that investors trust then short termism might be less of a problem. It may also be that the reporting process does not properly convey how companies create value.

The Basel framework has clearly encouraged a short term mentality in financial services.

Some pensions legislation, and arguably accounting requirements, encourage fund managers to move away from equities.

14. Are there measures to be taken, and if so, which ones, as regards the incentive structures for and performance evaluation of asset managers managing long-term institutional investors’ portfolios?

In the absence of better information relevant to the long term, investors and those for whom they invest (including pension fund trustees and individual savers) have nothing with which to assess performance or prospects other than past results.

Regulation should seek to ensure that investors and others can receive the right information, in the right form and that they can trust, so that they can look beyond the short term.

15. Should EU law promote more effective monitoring of asset managers by institutional investors with regard to strategies, costs, trading and the extent to which asset managers engage with the investee companies? If so, how?

More effective monitoring is clearly desirable. The EC should also consider how to ensure that institutional investors are more focussed on their fiduciary responsibilities to the millions of people who trust money to them. As companies close defined benefit pension schemes and individuals are encouraged to save for pensions through defined contribution schemes there seems to be an almost complete vacuum in terms of people who are looking after these savers’ interests. Over the last 10 years, few equity collective investment schemes have managed to keep up with inflation. They have demonstrably failed to provide the kinds of return forecast in sales literature. Meanwhile fund managers continue to take 2% or more a year as fees for ‘managing’ investments.

We would like the EC to consider how it can encourage investment institutions to be more accountable to individual savers. Communications from institutions to individuals, particularly about pensions, is detailed but largely incomprehensible to most people as projections are based on many assumptions and it is impossible for people to know whether they are realistic or not. A mechanism should be found that allows individual savers to take an interest in governance and engage with companies.

16. Should EU rules require a certain independence of the asset managers’ governing body, for example from its parent company, or are other (legislative) measures needed to enhance disclosure and management of conflicts of interest?

There should be more transparency but we doubt whether such change in the law can achieve much.

17. What would be the best way for the EU to facilitate shareholder cooperation?

At present only a few people within investment institutions have a real interest in corporate governance. Some institutions employ governance teams but most of them are small and have little real influence on investment decisions. Regrettably, some teams may struggle to justify their existence. Many fund managers remain to be convinced that good governance is important and many institutions think there is no point spending money on active engagement because all shareholders would benefit equally, they are content to let others work on their behalf.

The biggest risk to an investment manager is to underperform relative to other managers. The over-emphasis on such performance, on the part of investors, reinforces short termism and encourages herding. It is very much not in the best long term interests of savers. The fact that fund managers believe in diversifying and in investing in thousands of companies is a further reason why few are interested in engaging with companies.

It should be easier to build a case to support intervention if those interested in governance were to focus more on performance and what makes companies successful, and less on compliance with requirements which may have little merit. In the UK, the new Stewardship Code may encourage cooperation between shareholders. So far though it is mainly focussed on how investors monitor compliance with governance requirements rather than on governance performance and how principles are applied. Its value at present is mainly symbolic but this does help institutions with an interest in governance to persuade others to do so. It is therefore a potentially powerful means to an end.

18. Should EU law require proxy advisors to be more transparent, e.g. about their analytical methods, conflicts of interest and their policy for managing them and/or whether they apply a code of conduct? If so, how can this best be achieved?

19. Do you believe that other (legislative) measures are necessary, e.g. restrictions on the ability of proxy advisors to provide consulting services to investee companies?

Blind reliance, by those who should know better, on credit ratings on structured mortgage based assets and their synthetic derivatives contributed greatly to the boom then bust in credit markets. While proxy advisors have a value it would be better if investors pooled resources and formed their own opinions.

One reason why investors and proxy agencies focus on compliance with rule like provisions rather than look at how companies apply principles is that it is easier to do so. This means it is also cheaper and can be done by relatively inexperienced and junior staff. As a result there has been little pressure on companies to improve their reporting. Institutions must be prepared to put more money into looking at governance.

20. Do you see a need for a technical and/or legal European mechanism to help issuers identify their shareholders in order to facilitate dialogue on corporate governance issues? If so, do you believe this would also benefit cooperation between investors? Please provide details (e.g. objective(s) pursued, preferred instrument, frequency, level of detail and cost allocation).

We agree that transparency is important and companies should be able to identify their shareholders. In an ideal world shareholders would want to make themselves known to companies. Those who do not may wish to short stock or avoid tax.

21. Do you think that minority shareholders need additional rights to represent their interests effectively in companies with controlling or dominant shareholders?

22. Do you think that minority shareholders need more protection against related party transactions? If so, what measures could be taken?

Enhanced minority protection may be needed in some member states. The important principle is that regulation should ensure that all directors act in the interests of the company rather than any particular group of shareholders.

23. Are there measures to be taken, and is so, which ones, to promote at EU level employee share ownership?

We think employees should be encouraged to hold shares in companies they work for. Employees tend to have longer term interest and more personal capital tied up in the company that employs them than do other shareholders and board members. Employees could therefore be expected to take an active and informed interest in the governance of their companies and this is likely to be in the company’s long term interest.

However, employees should not be encouraged to concentrate all their investments in one place. If the company were to fail, the employees lose savings as well as their job and possibly their pension.

Comply or explain

24. Do you agree that companies departing from the recommendations of corporate governance codes should be required to provide detailed explanations for such departures and describe the alternative solutions adopted?

Yes, but we think the question confuses the issue. An explanation of how a company achieves good governance is more informative than simply saying it complies with a provision. It may be that a code requirement is inappropriate for a company, if this is so an explanation of why and how the company still upholds governance principles should be more than acceptable. Explanation should not be confused with failure to comply. Applying the principle and saying how is more important than compliance.

25. Do you agree that monitoring bodies should be authorised to check the informative quality of the explanations in the corporate governance statements and require companies to complete the explanations where necessary? If yes, what exactly should be their role?

In theory there should be no need for any monitoring body to do this as shareholders should do so. However, in practice, shareholders do not do this very well. We would like to see monitoring bodies championing good practice and encourage companies to give more informative explanations of how they apply governance principles. We would also like them to encourage shareholders to take more considered notice of such disclosures and use this as basis for constructive engagement. We believe this would be the most effective way to improve corporate governance practice. This way we might achieve the symbiotic relationship between companies and shareholders that the UK Cadbury Committee envisaged 20 years ago.